World: Can tax ever be “fair”?

In the growing debate over tax – and who pays what – "paying a fair share” has become one of the clearest rallying calls for both governments and the wider public. But for businesses working out what constitutes their fair share can be hugely problematic.

The list of major companies facing criticism for paying what is perceived by some to be too little tax — either overall or in specific jurisdictions — has been expanding rapidly. Scrutiny by the public at large, as well as legislators, has been directed at large multinational companies — many of them household names — around the world.

The problem is not one of illegality. The companies involved have always insisted that they obey existing tax laws and the authorities have not disagreed. The issue is much more difficult to address: fairness.

The overarching question is how the existing tax legislative framework, whose fundamental principles were developed many decades ago, can apply effectively to multinationals operating in today’s globalized environment. In particular, this relates to how corporations manage subsidiaries in jurisdictions with differing tax rates. In some cases, it is not even clear which country has legal power over income.

In addition, in the public mind, fairness is at the source of a number of tax-related issues at the domestic level. This should not be surprising. The perception of fairness has long been an important consideration in tax policy. As far back as 1776, Adam Smith, in his Wealth of Nations, describes four principles that should characterize taxation.

He puts equity or fairness first among these: "The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state.”

If anything, current economic conditions are increasing the importance of this element of a desirable tax system in public eyes. Jeffrey Owens, Senior Tax Policy Advisor at EY, notes that most developed countries are engaged in austerity programs to reduce debt, and higher taxes form an important element of many programs. "This brings an increasing emphasis on all taxpayers having to pay their fair share. That has become a political issue,” said Owens.

John Christensen, Executive Director of the Tax Justice Network, an NGO, agrees that austerity has focused attention on the debate about a fair share of tax, but believes that longer-term issues are also at play. "Until about a decade ago, there was very little public recognition that tax competition was even an issue,” he says. "As globalization has extended its reach, there has been a deeper understanding that tax laws have played an important part in shaping it.”

In that way, the debate over a fair share of tax is part of the broader discussion about how globalization should proceed in the years ahead.

What the law expects

Fairness is a powerful ideal, but a very difficult one to define, let alone achieve. It is also a highly subjective concept and even a basic understanding of it tends to vary over time.

Taxation arises from legally created and defined obligations. As Owens says, at the end of the day, governments decide what is fair through legislation. The difficulty then becomes determining what fairness means in the context of a given set of laws.

One key element of this is fairness to individual taxpayers as they try to negotiate the rules. Several court decisions are regularly cited to summarize one important view — that as long as the taxpayer stays within the letter of the law, it is unfair to demand more unless the government goes through the trouble of changing those rules.

In Britain, in the Duke of Westminster case of 1936, Lord Tomlin said: "Every man is entitled, if he can, to order his affairs so that the tax attaching under the appropriate acts is less than it otherwise would be. If he succeeds ... then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax.”

Around the same time, a distinguished American jurist, Learned Hand, noted in a 1935 case: "There is not even a patriotic duty to increase one’s taxes. Over and over again the courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible.”

The payment of tax, however, is not merely an individual activity. It involves discharging a responsibility to the state and, ideally, through the state to the broader society. This inevitably involves considerations of fairness to other taxpayers who share the burden of funding the government — and to fellow citizens who may benefit from state spending.

Accordingly, the letter of the law has never been the only consideration in the courts. The substance of a taxpayer’s activities has always been as important as the form.

Professor Graeme Cooper of the University of Sydney Law School said, "I don’t know that people ever would have been well advised to think that, as long as I can put together the right kind of form, I can survive scrutiny. The legal system doesn’t work that way.”

Indeed, it is ironic that Hand’s quote arose from a case, Gregory vs. Helvering, which established in the US the Business Purpose Doctrine — which is that transactions taken for no reason other than to reduce taxes could be disregarded by the authorities.

In recent years, the substance — or intent — of the law itself has become of ­ever-greater importance in deciding what taxpayers should be able to do. Owens points out that one of the major shifts in the OECD’s 2011 Guidelines for Multinational Enterprises was that in tax matters, corporations, while complying with the letter of the law, should also consider the intent of the law.

Judith Freedman, Professor of Taxation Law at the University of Oxford, notes that many countries are introducing general anti-avoidance rules (GAARs): "Yes, you look at the law, but you have to look at it in a purposive way. You can even look at shortcomings in the legislation. You can no longer say that, even if the law says something really stupid because of a technical problem, it will be the last word on the matter.”

From a legal point of view, then, fairness seems currently to boil down to taxpayers being allowed to take advantage of intended benefits in legislation when genuinely engaged in behavior that was meant to attract those benefits.

Societal norms

This is far from the full story, though. This argument assumes that the government got it right and that the law itself, when properly applied, should result in fair outcomes. Cooper said, "The problem underlying many of the current controversies over tax havens is not that people are evil, but that the rules are no longer producing outcomes that we like anymore.”

Christensen goes further: "Laws adopted in the early part of last century have not evolved to reflect a globalized economy and the emergence of digitized economies. They have fallen massively behind the reality of the new economy.” Complicating matters further, it is not just companies who may be pursuing aggressive tax planning; countries are also engaging in aggressive tax competition to compete for investment.

Fairness, though, is a social concept even more than a purely legal one. Tax positions that would survive robust judicial scrutiny can appear inappropriate to the public. Companies therefore may need to take steps even when they do not legally have to.

Freedman says, "There is certainly a perception among companies that reputation matters, although it may depend on the industry. A retailer, for example, might worry more than others about public opinion, and certain businesses would be quite proud of aggressive tax strategies that make shareholders very happy.”

Owens nevertheless believes that all executives have to think whether they can explain their tax strategy to the citizen in the street, and to consider whether they can argue that their company creates "public value” with their choices.

Reputational damage arising from what is seen as aggressive tax planning can affect more than sales. It may make it harder to attract talent and it is increasingly likely to lead to much greater scrutiny from tax officials. Owens says, "A company’s good corporate governance policy has to include good tax compliance.”

A fairer system in future?

Current efforts to improve the "fairness” of tax systems show how difficult it is for diverse groups to come to an agreement on what constitutes a more fair system and how that system should be implemented.

At the international level, the most prominent work in this area is currently being undertaken by the OECD on behalf of the G20. The new Action Plan on Base Erosion and Profit Shifting is an attempt to address various arrangements that give companies flexibility in choosing tax jurisdictions. The plan covers everything from regulatory consistency and administration to information sharing, tougher policies on transfer pricing and treaty abuse.

"This is one of the biggest challenges the OECD has taken on in the last five decades. It will require agreement between the OECD countries, the BRICS and others on what should be the international tax rules and how we should apply them in a consistent fashion,” says Owens. Given the difficulties involved here, some doubt whether this will move ahead anytime soon. "It may happen in my lifetime, but I doubt it,” says Cooper.

While recognizing the challenge ahead, some believe that the existing suggestions still do not go far enough. Even if OECD countries reach an agreement, Christensen believes the process will likely produce only "a band-aid resolution that can slightly ameliorate some of the problems,” as he puts it.

Moreover, the issues are far more than technical. The current international system, for all its faults, benefits any number of countries in different ways. Change that threatens these interests will be all the harder to carry out.

In Christensen’s view, the barriers to progress lie at a political level and have been there since the 1930s. "Some countries see a comparative advantage in using harmful tax competition as part of their overall development strategy,” he said.

Meanwhile, at the purely domestic level, the increasing implementation and use of GAARs can be seen as a way to prevent the use of tax positions that are considered to have unfair results. Freedman said, "GAARs align the law as interpreted by the courts and the spirit of the law.” They are easier to implement than multilateral agreements, but also less effective because they cover only national tax law.

It is difficult to discuss GAARs collectively, as details differ. Some, such as the Canadian and British ones, have extensive safeguards and have the potential to help clarify the law. GAARs, however, can create a serious problem in terms of fairness.

In seeking to prevent taxpayers from adopting unfair positions, the authorities may in turn be using a tool that is itself arguably unfair — not least by contributing to an increase in uncertainty.

"These laws are like your mother saying, ‘I don’t know what you are going to do and how, but I tell you now, you aren’t going to get away with it,’” Cooper said of the Australian GAARs experience. "It is inevitable that they are not written in a way that people will be able to see where the boundaries are.”

The use of GAARs can also have unintended consequences for the governments seeking to deploy them. In Australia, invoking the GAARs in some recent cases has undermined its utility because court judgments tend to define its scope in more detail than the legislation does, notes Cooper. "In order to restore equilibrium, bureaucrats had to rewrite the rule to get back its inscrutable terror.”

Perhaps the least problematic approach to enhancing fairness is one that uses legal requirements in ways that allow social expectations to have greater force. "If one concept will dominate tax in the next 10 years, it is transparency,” Owens says. He added that companies will increasingly be asked to be clearer about where income is raised and their global supply chains, so that tax authorities can have a global perspective.

This may not of itself make it harder for companies to take aggressive legal positions. Cooper says that, when authorities are looking at big business, the problem is not that they can’t find out what is going on, but that they can’t do anything about it. Increased transparency, along with country by country reporting, should it become widespread, will markedly increase the reputational dangers of aggressive legal positions.

Transparency, however, is a double-edged sword. Owens said, "Governments will also have to be transparent in their policy-making and in the way they go about implementing policies.” The next issue of Tax Insights will focus specifically on transparency.

Whether increased transparency leads to more fairness remains to be seen. Fairness has always been a necessary goal of tax, but it is an aim that is hugely difficult. The concept itself is problematic; it is a matter of seeking a balance between conflicting interests, rather than a single best solution for all cases.

Even so, governments, companies and individuals will increasingly need to wrestle with the issue, as societies that are now learning to live with less in turn demand that everyone pays their fair share.

WHY REGISTER WITH SAIT?

Section 240A of the Tax Administration Act, 2011 (as amended) requires that all tax practitioners register with a recognized controlling body before 1 July 2013. It is a criminal offense to not register with both a recognized controlling body and SARS.